LDI fallout will spur pension funds to seek life sector arrangements, Fitch says

Written by Adam Cadle

06/10/2022

The sudden need for pension funds to put up large amounts of extra collateral due to tumbling gilt prices will lead more UK DB pension funds to favour pension risk transfer deals with life insurers over LDI arrangements with asset managers, Fitch Ratings has said.

The rapid drop in gilt prices following the UK’s ‘mini-Budget’ on 23 September led to a sharp increase in collateral requirements from many LDI funds as derivative contracts protecting against lower interest rates moved significantly out of the money. The scale of the extra collateral requirements triggered a sell-off of gilts as pension funds scrambled to find the necessary cash. This exacerbated the fall in gilt prices and led to the Bank of England intervening to stabilise the market.

Fitch said “the crisis highlighted the risks of LDI funds that make substantial use of derivatives” and it believes pension schemes’ appetite for LDI solutions will be “greatly reduced as a result”.

“In particular, demand for leveraged LDI structures will have been dealt a severe blow,” Fitch Ratings added.

“We also expect pension schemes to be warier of untested non-insurance pension consolidators due to heightened risk aversion.”

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